United Continental Is Underestimating the Threat From Delta Air Lines

Today, United Continental is the top U.S. airline for flights to East Asia -- but how long will it last?

Jun 12, 2014 at 10:36AM

Today, United Continental (NYSE:UAL) is the undisputed leader within the U.S. airline industry for flights to East Asia. At its investor day last fall, United's leaders stated that the company's San Francisco hub has more non-stop service across the Pacific than any other U.S. airline hub. They also boasted that United has more flights to China than all other U.S. carriers combined.

However, American Airlines (NASDAQ:AAL) and Delta Air Lines (NYSE:DAL) are racing to catch up to United in Asia. Both carriers recognize that Asia is a key region for long-term growth. Delta's nascent hub in Seattle represents a particularly significant threat to United's position as the top transpacific carrier -- but United's leaders may be underestimating that threat.

Delta's growth in Seattle
In the last two years, Delta has made a concerted push to create a global gateway in Seattle that could rival United's operation in San Francisco. At the beginning of 2013, Delta had 5 daily nonstop flights outside of North America from Seattle. It flew to Tokyo, Beijing, and Osaka in Asia, and to its partners' hubs in Amsterdam and Paris in Europe.

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Delta is building an international hub in Seattle. Photo: The Motley Fool

Last year, Delta added a second daily flight from Seattle to Tokyo -- this one serving Haneda Airport, which is closer to the Tokyo city center than Narita Airport, where most international flights land. Delta also began service between Seattle and Shanghai in June. However, it cut its flight to Osaka in the fall due to weak demand and the depreciation of the yen.

Delta has continued its growth in Seattle this year. In March, it began nonstop flights between Seattle and London-Heathrow in conjunction with new joint venture partner Virgin Atlantic. This month, Delta is adding to its Asian route network with new daily flights from Seattle to Seoul and Hong Kong. As of next Monday, Delta will fly from Seattle to the top five business destinations in East Asia.

Delta is also rapidly increasing its domestic route network in Seattle to provide connecting traffic for its new international flights. In fact, by the end of 2014, Delta will have more than twice as many daily flights in Seattle as it did at the beginning of the year.

United vs. Delta
United Continental CEO Jeff Smisek doesn't seem too worried about Delta's growth. (He doesn't seem concerned about American's rapid growth in Asia, either: but that's a more reasonable position.) At an investor conference last week, he stated, "Our friends in Atlanta lack a gateway to Asia... The best gateway is already taken -- that's San Francisco."

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United Continental CEO Jeff Smisek doesn't seem concerned about Delta's growth in Asia. Photo: The Motley Fool

San Francisco does have two key advantages. First, it has a large local market for travel to Asia, due to its cultural association with many Asian cities and status as a major tech and banking hub. Second, United operates about 300 daily flights in San Francisco, while Delta has fewer than 100 daily flights in Seattle. (Delta can still offer other connections in Seattle through partner Alaska Air (NYSE:ALK), which operates a sizable hub there.)

However, Delta is likely to continue building up its operation in Seattle in the next several years. By the end of the decade -- either through organic growth or via an acquisition of Alaska Air -- it could grow its Seattle hub to the same size as United's San Francisco hub.

Delta's secret weapon in fighting back against United's San Francisco hub is geography. Due to its positioning in the northwest corner of the continental U.S., Seattle is hundreds of miles closer to East Asia than San Francisco.

For example, before last year, the best itinerary for a traveler going from Salt Lake City to Shanghai would have been on United through San Francisco: a total journey of about 6,750 miles. However, flying through Seattle cuts the journey down to 6,410 miles. From many U.S. cities, flying to Asia via Seattle is 5%-10% (and in some cases even 15%) shorter than flying through San Francisco.

The reduced flying distance will translate directly into a cost advantage for Delta. It will also allow Delta to utilize shorter-range planes, which are cheaper to acquire. The threat to United's San Francisco hub from Delta may be relatively modest today, but it will grow exponentially in the next few years as Delta expands in Seattle.

Foolish bottom line
United Continental is still the top dog today among the U.S. carriers for flights to Asia. It has the biggest transpacific hub in San Francisco, and supplements its service there with flights from Los Angeles, Chicago, New York, and Washington D.C. to East Asia. However, American Airlines and Delta Air Lines are both steadily increasing their transpacific service.

Delta's growing hub in Seattle is the most potent long-term threat to United's dominance on transpacific routes. Due to Seattle's positioning several hundred miles closer to Asia than San Francisco, Delta is likely to have lower costs for moving passengers through its hub than United.

Considering that Delta is a much more profitable company overall, that may be all the advantage it needs to disrupt a major piece of United's business. United Continental executives should take this threat a lot more seriously.

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Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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